Headlines about Tesla are being produced at a more rapid clip than the electric-car maker can manufacture its EVs, but the biggest ones are being underemphasized by the stock market. It relates to the world's largest car market — China — where competition between Elon Musk's electric-car company and local Chinese EV makers is poised to accelerate.
Tesla shares have moved this month on reports of production hiccups — even allegations it has resorted to making cars by hand — and when it was reported last Thursday that Consumer Reports will give only the Model 3 an "average" rating. But it's Monday's report that Tesla may become the first foreign automaker to produce in mainland China without a local joint venture partner — and a recent major change in the way the Chinese government will provide support for the electric-vehicle industry — that could really make or break the stock in the long term.
Reports over the weekend indicated that Tesla was close to finalizing a deal to produce in a free-trade zone in Shanghai. This would allow Tesla to keep its intellectual property secret but might force it to pay steep tariffs if it is not granted a special exemption — essentially, treating the cars as imports. Tesla had previously said it hoped to identify a production site in China by the end of the year.
The reported deal comes as China is implementing new incentives for EV adoption to replace expiring subsidies and push automakers onto more aggressive EV investment and production schedules.
"This will be the strictest and biggest EV plan worldwide, integrating European and California's EV policy together, and will give strong momentum for China's EV development," said Jiayin Song, a Beijing-based senior associate at U.S.-based Rocky Mountain Institute, which helped China devise its long-term climate change strategy. It will be the new driver for EV development after the Chinese government gradually shrinks the size of fiscal subsidies for new energy vehicles.
As the bulls and bears (22 percent of Tesla's public float were short the stock as of Oct. 10) fight over whether cash burn and production challenges can justify Tesla shares that are up more than 60 percent this year, the big moves by the Chinese government have to be weighed by investors.
Saudi Prince Alwaleed bin Talal, a billionaire investor, told CNBC on Monday that he wouldn't buy Tesla shares right now even though it is clear to him that demand for oil will diminish as "all other companies are going into the Tesla path of electric cars and even autonomous cars." He said, "Maybe some people believe the value is right. It's not for me to enter [at] that price. It's too exuberant for me right now."
The China EV market is somewhat of a double-edged sword for Tesla: The Chinese EV plan is a big endorsement of everything Tesla stands for at a time when the Trump administration is leaning more toward dialing back fuel efficiency standards in the United States. It's a chance to gain even more sales in China, where Tesla has been growing quickly. But Chinese government-subsidized local electric-car makers also are rapidly advancing. The major global auto companies — including Ford and GM — will also push further into the Chinese market and EVs as the government clarifies its support for these efforts.
Through the first half of 2017, Tesla sales in China were just under $1 billion, versus $2.8 billion in the United States. Year over year that represented a significant increase: In 2016's first half, sales in China were $252 million vs. $1.5 billion in the United States, according to a Tesla regulatory filing. That's a spike from roughly 16 percent of sales to 35 percent. In 2016, Tesla eclipsed the $1 billion mark in China in annual sales for the first time.
Musk said this summer at the National Governors Association meeting, "China's environmental policies are way ahead of the U.S. Their mandate for renewable energy far exceeds the U.S. Sometimes people are under the impression that China is either dragging their feet or somehow behind the U.S. in terms of sustainable energy promotion, but they are by far the most aggressive on Earth. It's crazy. In fact, the coalition of Chinese car manufacturers just wrote the Chinese government to beg them to slow down the mandate, because it's too much."
China's support for EVs is so "crazy" that implementation of the new regulations was pushed back a year to 2019 to give automakers more time; the Chinese government was originally pressing for implementation next year.
While dropping subsidies risks alienating some customers of Tesla and other carmakers, the Chinese government is banking on the idea that moves such as making it easier to get coveted perks, like license plates granting drivers access to certain areas of major (polluted) cities, will be at least as much of an incentive.
The new rules regulate both automakers' company-wide average fuel mileage and the percentage of electric and plug-in hybrid vehicles in their new car sales, Rocky Mountain Institute's Song said. It requires automakers, both domestic and global, to obtain 10 percent of credits from new-energy vehicles beginning in 2019. The rule applies to carmakers that manufacture or import more than 30,000 traditional vehicles annually. Those who fail to comply must buy credits or face fines, she said.
On Tuesday analysts at Piper Jaffray wrote that with Tesla's brand already established in China — especially at the highest price points — and with China pushing to have all cars powered by electricity at some point in the future, the American brand's position is relatively secure. Indeed, Piper thinks it will remain the market leader in China indefinitely.
The rules will help Tesla on one level, since it makes nothing but electric cars, but are intended to spur competitors at all price points to speed up the introduction and marketing of electric vehicles. And given the size of the Chinese market, and household incomes that are much lower than in the United States, it will create room for other players and more competition for Tesla.
Goldman analysts led by Tokyo-based Kota Yuzawa recently published an estimate that 8 percent of global auto sales, which today would represent almost 8 million cars and light trucks, will be all-electric by 2030. China is already the world's largest car market and biggest part of any forecast. But that puts Goldman at the bearish end of Wall Street projections: Morgan Stanley, a longtime Tesla bull, projects the same EV growth to reach 27 percent.
Goldman analysts allowed for a more aggressive "hyperadoption" scenario to reflect the growing possibility that government incentives and lower battery costs will drive even faster EV adoption — almost twice as fast as its base case.
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General Motors and Ford announced big new strategies to accelerate their own EV offerings at the same time that Tesla announced it missed already-modest third-quarter production targets for its crucial Model 3 mass-market sedan.
Especially in China, there's room for local Chinese competitors to undercut Tesla's price points, especially in outlying areas, even as more affluent cities let the company push ahead. That includes relative giants, like BYD and Geely Automobile Holdings, according to Morgan Stanley and Goldman Sachs research. These companies have something Tesla doesn't: profits.
Hangzhou-based Geely has been the hotter of the leading Chinese auto stocks with EV lines, riding an earnings beat for the first half of the year to see its shares more than triple in 2017. The company saw revenue more than double to RMB 18.1 billion, while profit climbed 128 percent to RMB 4.34 billion, about $660 million at current exchange rates, beating forecasts because the company managed costs better than had been expected, analysts who cover the company wrote. The company sold about 7,000 electric cars during the first half of the year, out of 621,731 total.
Tesla delivered over 47,000 cars in the first half of the year. But unlike Tesla, which had a net loss of near-$700 million in the first half of the year and has chosen to absorb large losses as it attempts to scale production and grab share in the luxury-EV market, Geely is solidly profitable. The company, which also owns Swedish automaker Volvo — which recently announced all new models will be electric after 2019 — is on track to make RMB 1.06 per share this year, for a relatively earthbound price to earnings ratio of 15, according to Goldman. That's still double the P/E ratios for automakers that make lots of gasoline-powered vehicles like Ford or GM, but way below the over 70 times 2019 projected profits that Tesla commands at today's prices.
Beijing Electric Vehicle, the EV division of state-owned BAIC Motor, sold 36,084 units through the first seven months of the year, according to Bloomberg.
BYD shares have been more earthbound this year until recently, but have still nearly doubled, all of it since Sept. 7 — all the local EV players have risen since the new Chinese EV plan became more clear. The local players have also long been supported by Chinese government subsidies.
Warren Buffett's Berkshire Hathaway has long owned a stake in BYD through a $230 million share purchase it made in 2008. BYD has been volatile over the years, but sold more than 46,000 electric and plug-in hybrid vehicles in the first seven months of the year, according to the China Passenger Car Association. Buffett's stake is now worth $27 billion, based on BYD's 217 billion market cap in HKD (Hong Kong Dollar).
BYD profits rose 91 percent in the first half of the year driven by sales of electric buses and trucks — with trucking an area Musk is eager to expand into — as well as battery and solar panel sales. Tesla is also becoming a major player with its battery gigafactory and solar company SolarCity. Tesla is working on a major battery project for an Australian utility, and Musk recently made comments about rebuilding Puerto Rico's hurricane-hobbled grid. Goldman wrote that BYD results were only in line with expectations, and the company lowered guidance for the rest of the year.
BYD, for its part, has pushed production of its green buses into the U.S. market as well as focusing on China, selling them to cities like Denver and companies like Facebook. It recently announced a plan to triple the size of its Lancaster, California electric bus and truck factory.
"Now more people view BYD as a global company," BYD Motors president Stella Li said on CNBC in July.
The next generation of Chinese EV names may include NextEV/NIO and Future Mobility Corp., according to Goldman analyst David Tamberrino. New entrants' flexibility may help them drive lower price points than Tesla can meet, and push new features and technologies to market faster, he said.
There have been reports circulating since last month about a relaxation in joint venture requirements for foreign automakers. Other major automakers including Ford, Daimler, and General Motors also have plans to produce in China. Daimler, which has had a joint venture with BYD for batteries that goes back years, also struck a JV with BAIC for EVs over the summer.
"Local manufacturers are moving at a much faster pace than global peers regarding implementation of new technologies," Tamberrino wrote. "They believe this creates greater showroom traffic and interest in the brand."
But one thing they won't do is catch Musk by surprise. He has been saying for years that China may ultimately be No. 1 in sales for Tesla even if it remains a distant second to the U.S. today. "Long term we might sell more cars in China than the U.S., just because the Chinese market is so huge," Musk said as far back as 2014. Luxury-car sales, in particular, do well in China: Almost half of all Mercedes S class sedans are sold in China.
—By Tim Mullaney, special to CNBC.com